Analyzing the Sustainability of India's Current Account Position Following the Reforms of the Early 1990s
| DOI | https://doi.org/10.1108/jabs.2010.4.2.86 |
| Date | 21 May 2010 |
| Pages | 86-92 |
| Published date | 21 May 2010 |
| Author | Niloufer Sohrabji |
Analyzing the Sustainability of India’s Current Account
Position Following the Reforms of the Early 1990s
Niloufer Sohrabji∗
Simmons College
ABSTRACT
Following the 1991 crisis, India undertook reforms that liberalized trade and investment. India faced current account deficits for
most of the period following these reforms. This paper analyzes sustainability of India’s current account position over the last
decade using the intertemporal solvency model of Hakkio and Rush and Husted. In this theoretical framework, the intertem-
poral solvency constraint is satisfied if there is cointegration between inflows and outflows of the current account. This paper finds
cointegration between the series when allowing for a structural break using the Gregory and Hansen procedure. Dynamic generalized
least squares (GLS) estimation shows a strong relation between India’s current account inflows and outflows. On the basis of the
empirical results, this paper concludes that there has been an improvement in trade patterns and despite experiencing deficits, India’s
current account position is sustainable.
Keywords: India, National economy, Economic sustainability
1. INTRODUCTION
This paper examines the solvency of India’s current account position
over the last decade. Large and deteriorating current account deficits
have played a role in the Mexican peso crisis in 1994, the East Asian
crisis in 1997-1998 and Turkey’s crisis in 2001. India experienced
large current account deficits in the late 1980s and suffered a balance
of payments crisis in 1991. Following the crisis, India undertook
reforms that liberalized trade and investment. For most of the period
since these reforms, India has experienced trade and current account
deficits. This raises concerns about the liberalization reforms, including
the possibility of another crisis, and makes it important to study India’s
current account position in this period.
Trade and current account deficits need not be problematic. If trade
deficits are linked to poor terms of trade or because of a weak pro-
duction base, then high import bills are a drain on the economy. On
the other hand if a country is increasing imports of capital goods it indi-
cates improvement in productive capacity which helps future trade bal-
ances. This is the basis of the intertemporal solvency model proposed
by Hakkio and Rush (1991) and Husted (1992) which analyzes cointe-
gration between exports and imports and other outflows of the current
account.
Using the above theoretical framework this paper analyzes sustain-
ability of the Indian current account since the reforms of the early
1990s. Although cointegration between inflows and outflows is
rejected for the period as a whole, there is evidence of cointegration
when allowing for a structural break. Taken together these results indi-
cate that there is an improvement in the current account position in this
period. On the basis of cointegration results, the long run relationship
between exports and imports and other debits is estimated. This paper
finds evidence of a strong relation between current account inflows and
outflows and concludes that despite the deficits, India’s current
account position is sustainable.
The paper is organized as follows: the next section provides back-
ground on India’s current account position which is followed by a
review of the literature. Section 4 presents the theoretical framework
and empirical methodology for examining current account sustainabil-
ity. Section 5 discusses the empirical results and the last section
concludes.
2. BACKGROUND
To determine the current state of India’s external position it is useful
to analyze the major changes in the current account over the last few
decades. Figure 1 plots the trend in the overall current account position
for India from 1980 to 2006 using two measures, levels of current
account balances and the ratio of current account balances to GDP.
Figure 2 maps out the different components of the current account
including merchandise trade balance, services trade balance, net unilat-
eral transfer account and net investment account. Together these
graphs provide an interesting portrait of the Indian current account pos-
ition over the last three decades.
India had a deteriorating current account position in the late 1980s
(Figure 1). The current account deficit was $2 billion in the early
1980s (1980-1984) which jumped to over $4 billion by 1985. This
trend continued for the remainder of the decade with the deficit exceed-
ing $7 billion by 1990. This same trend is observed in the current
account deficit to GDP ratios. This ratio was approximately one
∗Corresponding author: Simmons College, Fenway, Boston, MA 02115, USA. E-mail: sohrabji@simmons.edu
The author is indebted to two anonymous referees for their insightful feedback. All errors remain the author’s.
86 Journal of Asia Business StudiesSPRING 2010
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